Prepaid insurance is the amount of the insurance premium paid by the company during an accounting period that has not expired during the same accounting period and, therefore, the unexpired part of this insurance will be presented as an asset in the company’s balance sheet.
Simply put, it refers to the portion of the unpaid insurance premium, which is paid in advance by the company and is currently not due.
An insurance premium is an amount that an organization pays on behalf of its employees and other policies to which the company has rendered. Generally, the insurance premium is paid monthly or quarterly. The expense, unexpired and prepaid, is entered in the books of account under current assets. And the expense for that period is shown in the income statement.
Is prepaid insurance an asset?
The Fast Track company purchases one year insurance for its delivery truck and pays $ 1200 for the same amount on December 1, 2017. Now that you have prepaid for the services to be used, it is classified as an asset.
In this case, the prepaid insurance will be classified as a current asset on the balance sheet, as shown below.
This means that the insurance expense each month is $ 1200/12 = $ 100. For a month between December 1 and December 31, $ 100 of insurance is exhausted.
Let’s look at the balance sheet after one month on December 31, 2017.
Please note that the amount stated for prepaid insurance in the balance sheet assets is $ 1,200 to $ 100 = $ 1,100.
Insurance used for December will be reported as an insurance expense in the December income statement. It is shown below in the example income statement.
Entries in the prepaid insurance journal
Suppose XYZ Company which has to pay its Employee Liability Insurance for the entire fiscal year ending December 31, 2018 is $ 10,000. The company paid $ 10,000 in insurance premium for the entire year at the start of the first quarter.
The following journal entry will be forwarded and will be reflected in the books of XYZ Company.
Journal entry when prepaid insurance is paid
- Prepaid insurance is debited which indicates the creation of an asset in the balance sheet
- While the bank is credited an equal amount which balances the accounting rule (for each credit there is an equal debit)
Journal entries when prepaid insurance is due
At insurance maturity, for each quarter, i.e. $ 2,000 will be subtracted from the prepaid account and is shown as an expense in the income statement for that reporting quarter
- The income statement for the quarter ending will show an expense of $ 2,000 under the heading Insurance expenses
- In Company XYZ’s balance sheet, the closing balance of the current account prepaid account will show a balance of $ 8,000 ($ 10,000 – $ 2,000) for the quarter ending because the amount owed for the quarter was spent in charges for this period.
- The amount owed and expensed this quarter is also known as the cost of the period because it is the cost to be incurred during that period.
- The process of deducting the account periodically is often referred to as depreciation
Adjustment entry for prepaid expenses
Making adjusting entries to balance the books is often helpful, saving us from making an entry for new business transactions. To make an adjustment posting, you must debit the actual expense and credit the prepaid expense account throughout the amortization. The prepaid account will come to the NIL balance at the end of the accounting period, and all accrued expenses in the income statement.